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July 8, 2010

Special Report: 2010 Annual Top Wealth Manager Survey

The top Wealth Managers are looking to restart growth, find new clients and new markets, and reinvigorate their strategy and their people.

Managing a Top Wealth Manager today is a lot like driving a racecar--it is all about the art of knowing when to push the brake and when the step on the accelerator. A little too soon and you can crash, a little too late and you can be left behind. Just surviving is not enough--the top Wealth Managers in the U.S. are looking to restart their growth, find new clients and new markets, and reinvigorate their strategy and their people.

Collectively, they influence a large portion of the high-net-worth client base and serve as thought leaders for their investment industry peers. What brings them together is the desire to excel at their profession and the ambition to achieve business excellence and meet the needs of their clients. The financial crisis of 2008 and 2009 took some clients, assets and opportunities away from them--the top firms are eager to regain what they lost and drive forward again.

Growth is vital for an advisory firm. Growth creates opportunity and opportunity attracts talented people. Talented people, in turn, attract more clients and more opportunities. When the momentum is lost, the opposite becomes true--the lack of opportunities causes people to leave, and as people leave, capabilities and clients soon follow. The race is already on as to which firms will be able to restart their growth the fastest and thus create the most opportunity; they will be the ones that will be able to attract the most talent and consequently see the most growth in the next cycle.

Assets under management (AUM), has already recovered from the lows in 2008 and early 2009, and on average firms have more AUM today than they have had in their history. As of the end of 2009 the average AUM for participants was $877 million--a 24% increase from the lows of December 31, 2008. Most of that recovery was due to market performance with a relatively small contribution from business development: on average, the firms increased their client count from 352 to 367.

While the assets have returned to the pre-crisis level, revenues are slow to follow. On average, participating firms had $3,059,000 in revenue in 2009 compared to 3,198,000 in 2008. Staff productivity has not yet recovered, even though many firms went through staff reductions and painful layoffs.

The storm is over but the challenge is not. When asked about their biggest concerns today, firms overwhelmingly cite their ability to grow, the regulatory climate and productivity initiatives such as technology and operational support. The firms also recognize the importance of preserving their team and attracting talented employees again. The financial resources are there and very few firms are expressing concerns over profitability, in sharp contrast with the 2009 survey in which that was the overwhelming concern.

The executives of the Top Wealth Managers in 2010 and 2011 will have to find a way to:

? Time the expansion of staff and reinvestment in the firm with the recovery in the market. Revenues are returning but the volatility of the market makes all firms nervous about premature expansion.

? Manage employee issues brewing under the surface very carefully. In many firms, employees have not received bonuses and raises for two years. Firms that embark on growth early will have the ability to lure away the best talent that may be tired of waiting. They will have to take the risk of "pushing the gas pedal too early," though.

? Prepare for slower growth, slower gains in productivity, and possibly, a slower increase in equity value. This in term may mean slower increases in owner income and slower career tracks. Such an adjustment of expectations will test the culture of many firms.

While growth is essential to solving these challenges, growing larger is not, in and of itself, a solution. Larger firms did not seem immune to the decline in revenues and assets. All firms suffered in the downturn and all firms are recovering equally fast. Revenue changes are somewhat more differentiated by size, and will have to be managed. Revenues in the largest firms (those with over $1 billion in AUM), declined 2.6% in 2009 compared with a decline of 8.1% for mid-sized firms and a drop of 5.3% for the smallest firms (under $500 million), however size alone does not seem to provide a decisive advantage. Note that the revenue drop occurred despite the growth in AUM we see in the graph above due to the timing of revenues and asset appreciation.

Having larger clients is not always the answer: While the largest firms in the industry have a clear advantage in attracting the largest clients, they have not been able to translate that advantage into productivity gains. Firms with over $1 billion in AUM average over $32,000 in revenue per client. By comparison, smaller firms--those with AUM of under $1 billion--average $17,123 and $16,355 in revenue per client, respectively, for mid-sized and smaller firms.

The crisis made firms very aware of the impact smaller clients have on their overall productivity and profitability. Firms became more sensitive to the fact that some of their smaller relationships may not be profitable if the cost of professional time and the opportunity cost of resources were to be fully allocated. As a result, many firms increased their minimum account sizes. The largest firms in the industry have an average client minimum of $4,174,000 compared with $2,394,000 for mid-sized firms and $791,000 for smaller firms.

Account minimums provide only part of the answer. A firm's ratio of clients-per-professional and staff is, perhaps, a much more critical factor. It appears that an advantage that large firms enjoy--having larger relationships, on average--is destroyed by the need to surround clients with more staff. As a result of the lower ratio of clients-per-staff, the productivity of wealth management firms is actually inversely related to their size: the largest firms have the lowest productivity. In 2009 the largest firms were averaging $266,084 per staff, compared with $305,853 for mid-sized firms and $305,572 for the smallest firms.

Some of the low productivity of the largest firms may be coming from the need to maintain the management infrastructure of a larger organization. After all, the vast majority of the smaller firms are owned, managed and operated by the same team of advisors who also service clients, while larger firms have dedicated professional managers. Firms over $1 billion in AUM had, on average, three professional managers who are not involved in client service, while mid-sized firms have one manager and the smallest firms had none.

It also appears that the pricing of the largest clients is very aggressive and is creating some productivity issues for the firms who service them. The average AUM yield (the ratio of revenue to AUM) was 42 basis points for the largest firms (meaning averaged $4,200 of revenue for every $1,000,000 in AUM) compared to 61 basis points for the mid-sized firms and 117 for the smallest firms. The reduction in productivity does not by itself signal a reduction in profitability but it means that the firm has to be even more careful about managing expenses and leveraging its most highly paid professionals.

There seems to be an inflection point in the relationship between productivity and pricing, at which point the gains of working with larger relationships are much smaller than the rapidly declining productivity. It is difficult to pinpoint that inflection based on the data gathered, but if we analyze the statistics in terms of average revenue-per-client, we can see that firms that focus on the wealthiest clients have very heavy staffing requirements--perhaps heavier than the revenue gains they realized.

Firms that service clients with over $10 million in AUM maintain a 1 to 30 ratio of clients per professional and 1 to 18 in terms of clients per staff (staff includes professionals, operations and management). In comparison, firms that work with less wealthy clients maintain a ratio of 46 clients per professional and 25 clients per staff. What is remarkable is that firms that service clients with $5 million to $10 million assets maintain almost the same ratios as the firms that service clients with under $5 million in assets. This means that they gain a significant revenue-per-client increase with minimal cost increase.

Pricing of the assets contributes to the drop in productivity. In fact, if we compare the typical yield on AUM (revenue to AUM) by client size, we find that the typical firm that services clients under $5 million in AUM has a yield of 111 basis points while the typical firm servicing clients with over $5 million in AUM has average yield of 57 basis points. Both firms maintain almost the same ratio of clients per professional, but the firms that service larger clients increase their revenue per client by 43%--from $11,558 per client to $16,551--a clear improvement. Further increases in client size, however, lead to a significant drop in clients per professional for relatively smaller increases in revenue per client. We saw that firms that service clients over $10 million in AUM have only 30 clients per professional and 18 clients per staff.

To summarize, it appears that there are two inflection points in the market positioning of wealth management firms that need to be carefully considered:

1. The service model appears to get dramatically more expensive once a firm enters into competition for clients with over $10 million in AUM. The ratios of clients per professional drop almost 50% and the cost increase is in danger of outweighing the gains of more revenue, at least in productivity terms.

2. The pricing competition appears to increase dramatically once a firm starts competing for clients with over $5 million in AUM. The clients do not yet require extensive change in service and staffing but the typical firm servicing clients with over $5 million in AUM is yielding 57 basis points compared to 111 basis points for firms who service smaller relationships. These diminishing returns in pricing may threaten the profitability of firms that are seeking to upgrade their client base.

Larger clients are not always the most profitable ones. It appears that, before looking to enter into more and more rarefied territory of wealth, a firm should consider whether it is about to cross the inflection point for diminished pricing and then productivity. At some point, wealthier clients mean more aggressive pricing and eventually more cost than the incremental gain in revenue.

This relationship is very clearly pronounced for family offices and multi-family offices. Firms that consider themselves a family office have on average $212,000 in revenue per staff compared to firms who are not a family office and who have $313,000 in revenue per staff. Of all participants, 56 firms (16% of participants) consider themselves a family office or a multi-family office.

Much has also been said about consolidation in the industry, and 11% of all the firms in the survey are part of a larger entity--a bank, an industry consolidator, CPA firm or other type of entity. The firms that are part of another entity tend to be much larger and have, on average, $2.614 billion in AUM compared with firms that are owned by the advisors, which have AUM of $616 million.

The presence of institutional ownership should provide a firm with better access to capital, more structured management process and better ability to deal with succession and employee retention. At the same time, the presence of an institutional owner may complicate the management of the firm, may slow down its reaction to the market and may discourage some of the more entrepreneurial employees or owners.

It is unfair to put all institutional owners in the same category, as some are merely passive investors while others seek more active involvement in the management of the firm or have a more strategic approach to combining the capabilities of the acquirer with those of the target. Still, there is some evidence that firms with institutional ownership had a harder time in the crisis and are slower to recover. On average, AUM for acquired firms declined by 16.2% in 2008 compared to 4.7% for the advisor-owned firms, and AUM increased by 22.4% for acquired firms in 2009 compared to 23.9% for advisor-owned firms.

In addition to the diverse ownership structures, there is also diversity of regulatory models - 29% of the firms in the study report having a Series 7 FINRA license and a broker-dealer relationship.

Hybrid firms (those with a broker-dealer and RIA registration) had, on average, more assets under management with $1.220 billion compared to $736 million for RIA-only firms. At the same time, it does not appear that the broker/dealer relationship is strategically critical for those firms. Very few of the participants cite their broker/dealer as one of the top three strategic relationships they have. Instead, it appears that the custodian plays a key role as a business partner and broker/dealers one of less significance to the Top Wealth Managers.

The custodians, on the other hand, appear in virtually every survey as a critical relationship. More than half of participants cite Schwab as their "primary" custodian, followed by Fidelity, TDA, Pershing and others. Notable is the presence of Raymond James and LPL in the custodian role--as both are better known as the two largest independent broker/dealers.

Firms in the survey say that they need better performance reporting tools from their strategic partners, better integration of technology and flow of data, and more sophisticated trading and rebalancing engines. Most of all though, they seek growth opportunities--many participants would like to see their strategic partners generate referrals and help create growth.

Growth is essential to the future of the independent wealth management industry. After all, even the largest firms in the industry are still, on average, 40-person organizations with heavy dependence on their owners and key professionals. This is their strength and their weakness. The independent side of the industry is still young, and still in the invention stage with respect to its client-service models and management practices. There is the opportunity to gain a sustainable advantage over the competition and develop momentum internally. The ability to time opportunity with investment in growth will be critical, though. There is a sense throughout the industry that we should be pushing the accelerator but it is scary to lift your foot off the brake after the near-miss experience. Still, as IndyCar champion Mario Andretti once said: "If you feel like you are in control, you not driving fast enough."

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